Strategic Capture of Monitors: Evidence from Pollution Control in China

Third-party monitors are commonly deployed to mitigate agency problems in multi-layered organizations. Yet these third-party relationships may themselves be subject to agency concerns. We examine how third-party monitoring can be undermined by collusion between monitor and agent, in air pollution monitoring in China. We exploit an outsourcing reform that transferred control of pollution monitoring stations from local governments to third-party firms selected by the central government. We find that local governments significantly increased procurement transactions with their assigned monitor post-reform. Additionally, following these transactions, reported air pollution from monitoring stations declined, as did enforcement actions against nearby polluting firms.